About 30% of woke Denver's downtown office space is vacant - and that doesn't include "zombie buildings"

[useapen]

Marcel Arsenault didn’t mince words at this week’s Colorado Business
Economic Summit.

The real estate investor said he’d dumped many of his office holdings by
last year as the values seemed unsustainable and interest rates shot up,
amid other depressing trends. But he held on to strong clients like
Amazon, who “would pay their leases.” Recession is on the way, he said
Monday during the annual event organized by the Leeds School of Business
at the University of Colorado.

“We all got the memo on office so most of us know that office is a four-
letter word,” said Arsenault, CEO and founder of Real Capital Solutions, a
real estate investment firm in Louisville.

The Denver office market continues to struggle more than three years after
office workers headed home to work remotely. While some employers now
require folks to show their faces on site, the data points to many
companies cutting back on how much space they rent.

Arsenault, speaking during the hot-topic session on commercial real
estate, shared a chart showing a blue line shooting upwards with a red
line close behind. The blue represented the substantial increase in
subleasing in the Denver-Boulder market since 2020, as tenants in long-
term leases downsized and tried to recover rent by finding others to take
over leases.

https://i0.wp.com/newspack-coloradosun.s3.amazonaws.com/wp-
content/uploads/2023/12/Real-Capital-Solutions-CO-biz-econ-outlook-
2024.png?resize=768%2C499&ssl=1

But now, subleasing is past its peak and that’s contributing to an even
higher overall vacancy rate. Add in other factors, such as fewer out-of-
state companies looking for space in Denver, and another 2.1 million
square feet of office space in the pipeline and the prognosis for next
year is bleak.

“Even without a recession, we believe the vacancy will go up,” Arsenault
said. “And if you go back to the last recession, the Great Recession, (the
rising vacancies trend) is already much worse now than it was in the Great
Recession. So it ain’t good.”

In the third quarter, office vacancy rates in downtown Denver hit a high
of 30.6% in the third quarter, the first time it’s been above 30% since
2000, according to real estate brokerage firm CBRE. The overall Denver
metro area saw office vacancy rates increase to 22.8%, up 110 basis points
from the second quarter and 220 basis points from a year ago.

Remote workers and zombie buildings
As business recovered from the disruptive pandemic, the real estate
industry was already anticipating a new type of office environment.
Creating hybrid spaces that required less space and fewer desks but
provided more shared conference rooms for in-person meetings became the
fashion. But last year, companies from Amazon to Tesla began instituting
return-to-office policies because they said there was lack of engagement.

Since 2022, the percentage of full-time workers who are completely remote
has dropped and stabilized around 20%, Real Capital Solutions Director of
Research Dan Sorrells said. Meanwhile, the percentage of hybrid workers
has been rising, now between 40% and 45%, and may also stabilize.

In industries where in-person work isn’t absolutely necessary, including
arts and entertainment, finance, professional business services and real
estate, fully in-person workers make up 30% to 40% of the total, and more
people work hybrid schedules, Sorrells said.

But whether companies have adopted a remote or hybrid workforce, or have
seen business suffer due to the economic decline, that’s created other
issues, like “zombie buildings,” or office properties that are leased but
aren’t being used, said Carl Koelbel, chief operating officer at developer
Koelbel & Company.

“We’re seeing office buildings that are effectively worth their land
price,” he said.

Higher vacancy rates are contributing to the development of new projects.
These days, Koelbel said, banks are asking for more liquidity, which is
something he’d never dealt with before.

“There are some asset classes that are just not possible (for us) right
now and office is certainly one of them,” Koelbel said. “I think
construction financing is going to be a struggle across all asset classes
for the next couple of years.”

Office subleases are expiring
The sublease market is no longer growing — dropping below 6 million square
feet in the Denver metro for the first time since December. And that’s
kept prices flat. Lease rates were up 1.3% from last year at $32.53 per
square foot, although CBRE noted that there’s more behind-the-scenes
negotiating going on for free rent or other concessions. There’s still
interest in office space. Online gambling company Bet365 took over a
60,000-square-foot sublease in Denver vacated by online stock-trading
company Robinhood.

Anthony Albanese, CBRE’s senior vice president, pointed out that there’s
still demand, but it’s mainly for the Class A space, which is the newest
space with all the amenities.

“People are painting with too broad of a stroke on ‘the office market’ and
it is creating confusion,” Albanese said in an email. “The Denver market
has experienced a bifurcation between the struggling Class B and C office
product and Class A office product, which is preferred by an increasing
number of tenants seeking a ‘flight to quality.’”

That’s been common in markets like Denver, which seems like it’s been full
of skyscraper construction since before the pandemic. CBRE’s stats show
that the Class A leases for the Denver Metro area were 77% of all
transactions in the third quarter, while Class B leases were 23%. In the
full year prior, 69% of all leases were Class A, while 29% were Class B
through the third quarter.

Still, he said, “given the increased demand for quality in the face of new
construction supply constraints, we expect the Class A office market will
continue to experience lower vacancies and increased rental rates as
tenants compete for a diminishing number of prime options.”

And yes, he’s seeing a lot of incentives, including “historically high”
tenant improvement allowances and free rent to relocate to the newer
spaces. Landlords from older Class B buildings are, meanwhile, discounting
the rent if they can afford it. Otherwise, those that are
“undercapitalized are becoming obsolete.” As for Class C? He predicts
those will exit the office space and be redeveloped for another use.

“The investment (of older buildings) into alternative uses presents an
opportunity to revitalize our cities and create a more vibrant and diverse
environment through all uses that mutually benefit each other, i.e.,
residential, retail, office, and mixed-use developments,” he said.

https://coloradosun.com/2023/12/07/denver-metro-office-vacancy-empty/